Evaluating the Liquidity and Solvency of a Company Identify whether the following statements are true or false. a. The current ratio is a measure of a firm's solvency. Answer 1 TrueFalse b. Free cash flow is a measure of a firm's liquidity. Answer 2 TrueFalse c. The return on sales ratio is a measure of a firm's solvency.Answer 3 TrueFalse d. The debt-to-total-assets ratio is a measure of a firm's solvency. Answer 4 TrueFalse
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Breanna O.
Liquidity ratios are used to measure a firm's ability to meet its obligations as they come due. Two of the most commonly used liquidity ratios are the: (1) Current ratio and (2) Quick, or acid test, ratio. The current ratio is the most commonly used measure of solvency. Its equation is: If a firm is having financial difficulty, it typically begins to pay its accounts payable more slowly and to borrow from the bank—both of which will increase its current liabilities, causing a decline in the current ratio. The quick ratio is a measure of a firm's ability to pay off obligations without relying on the sale of inventory, which are typically the least liquid of a firm's current assets. Its equation is:
Mauya M.
11. An analyst observes the following data for two companies: Company A ($) Company B ($) Revenue 4,500 6,000 Net income 50 1,000 Current assets 40,000 60,000 Total assets 100,000 700,000 Current liabilities 10,000 50,000 Total debt 60,000 150,000 Shareholders' equity 30,000 500,000 Which of the following choices best describes reasonable conclusions that the analyst might make about the two companies' ability to pay their current and long-term obligations? A. Company A's current ratio of 4.0 indicates it is more liquid than Company B, whose current ratio is only 1.2, but Company B is more solvent, as indicated by its lower debt-to-equity ratio. B. Company A's current ratio of 0.25 indicates it is less liquid than Company B, whose current ratio is 0.83, and Company A is also less solvent, as indicated by a debt-to-equity ratio of 200 percent compared with Company B's debt-to-equity ratio of only 30 percent. C. Company A's current ratio of 4.0 indicates it is more liquid than Company B, whose current ratio is only 1.2, and Company A is also more solvent, as indicated by a debt-to-equity ratio of 200 percent compared with Company B's debt-to-equity ratio of only 30 percent.
Akash M.
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